Cherry Hill Mortgage Investment Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014; filed August 12, 2014. The company invests in residential mortgage-backed securities (RMBS) and excess mortgage servicing rights (Excess MSRs). It began operations after its October 2013 IPO, so 2013 comparative results largely reflect a pre-operating period and are not directly comparable.
Financial results and position
| Metric | Q2 2014 / June 30, 2014 | Six months 2014 / change |
|---|---|---|
| Interest income | $6.137 million | $12.148 million |
| Interest expense | $1.006 million | $1.953 million |
| Net interest income | $5.131 million | $10.195 million |
| Net income (loss) attributable to common stockholders | $(652,000); $(0.09) per share | $78,000; $0.01 per share |
| Comprehensive income (loss) | $4.940 million | $9.029 million |
| Cash from operating activities | Not presented quarterly | $16.471 million |
| Cash and cash equivalents | $14.452 million; restricted cash $5.131 million | Cash increased $4.077 million from year-end |
Q2 total income was $666,000 after net losses on derivatives and Excess MSR fair value, partly offset by net interest income and a realized RMBS gain. The quarter included a $2.705 million unrealized derivative loss and a $1.648 million Excess MSR valuation loss. RMBS unrealized gains of $5.595 million were recorded in other comprehensive income, explaining why comprehensive income was positive despite the net loss.
At June 30, total assets were $463.598 million, including $337.662 million of RMBS and $102.422 million of Excess MSRs. Total liabilities were $300.844 million and stockholders’ equity was $162.754 million. Repurchase-agreement debt was $293.747 million, up from $261.302 million at December 31, 2013. Management reported RMBS debt-to-equity leverage of approximately 6.5:1. The RMBS portfolio’s net interest spread was 1.59%, compared with 1.43% at year-end.
Six-month investing cash use was $36.032 million and financing cash provided was $23.638 million. Repurchase borrowings were short-term, with a 0.36% weighted average rate after swaps, 57-day weighted average remaining maturity, and 5.4% weighted average collateral haircut. The company reported $314.5 million of collateral, including cash, against repurchase agreements.
Material changes and operating developments
- RMBS carrying value rose to $337.662 million from $286.979 million at year-end, while Excess MSRs declined to $102.422 million from $110.306 million. RMBS portfolio growth included purchases; the company reported $65.055 million of RMBS purchases and $12.645 million of sale proceeds in the first half.
- RMBS generated $8.950 million of six-month unrealized gains in other comprehensive income, which management attributed primarily to lower interest rates and tighter mortgage spreads. There were no other-than-temporary impairment charges on RMBS.
- Excess MSR fair value declined $978,000 over the first half. In Q2, Pool 1’s value fell by approximately $1.6 million, which management attributed primarily to actual prepayment speeds exceeding modeled assumptions; Pool 2’s value was approximately flat for the quarter.
- The company purchased additional Excess MSRs in 2014 through its flow-and-bulk arrangement with Freedom Mortgage. The acquired interests related to mortgage pools with approximately $334.7 million of original principal balance in aggregate, separate from the larger original pools.
- Operating expenses rose as the company continued to build its operations. Q2 general and administrative expense was $642,000 and affiliate management fees and expense reimbursements totaled $679,000.
Outlook, risks and contingencies
The filing provides no specific earnings, portfolio, or dividend guidance. Management stated that available liquid assets and expected operating cash flows should cover anticipated needs over the next 12 months, including current portfolio financing, flow purchases of Excess MSRs, potential margin calls, and operating costs. Longer-term liquidity may rely on additional borrowing, equity issuance, asset sales or refinancing. The company also said it was seeking licenses and approvals for its taxable REIT subsidiary and exploring Federal Home Loan Bank membership; a regulatory moratorium on mortgage-REIT captive insurers could delay or prevent access to that financing.
- Interest rates, prepayments and valuation: RMBS, derivatives and Level 3 Excess MSRs are sensitive to rates, spreads, prepayment speeds, delinquencies and discount rates. Excess MSR valuation relies on discounted cash flow models and significant unobservable inputs. A hypothetical 20% increase in the discount-rate assumption reduced estimated Excess MSR fair value by 9%; a 20% increase in voluntary prepayment assumptions reduced it by 6%. A hypothetical 100-basis-point rate increase reduced estimated RMBS value by 5.16%.
- Funding and liquidity: Repurchase agreements are short-term and generally uncommitted; counterparties may demand additional collateral or decline to renew financing. Margin calls or reduced collateral values could force asset sales.
- Servicer and related-party concentration: Freedom Mortgage services the company’s Excess MSR pools and is affiliated with the external manager; both are controlled by the company’s chairman. If Freedom Mortgage is terminated as servicer, the company’s rights to related Excess MSR cash flows may terminate. Management fees are 1.5% annually of stockholders’ equity, and the filing notes that related-party terms may be less favorable than arm’s-length terms.
- Contractual exposure: Under Ginnie Mae acknowledgment arrangements, the company could be required to make certain payments if Freedom Mortgage fails to pay security holders, potentially even for loans for which the company owns no Excess MSRs. Management considered material loss remote and recorded no liability. No material legal or regulatory claims or legal proceedings were reported.
- REIT and regulatory status: Failure to qualify as a REIT could result in material taxes and loss of REIT status for subsequent years. The company also seeks to maintain its Investment Company Act exclusion.
The company declared a second-quarter dividend of $0.51 per common share, payable July 29, 2014. It had declared $0.50 per share for Q1. Management cautioned that dividends, taxable earnings, and GAAP earnings may differ materially.
Most important facts for investors to verify
- Whether Excess MSR valuation assumptions—especially prepayment speeds, discount rates and uncollected-payment estimates—remain supportable, and how subsequent results compare with the Q2 model.
- Current repurchase-agreement balances, renewal terms, collateral haircuts, counterparty concentration and capacity to meet potential margin calls.
- Actual performance of the Freedom Mortgage servicing and recapture arrangements, including the effect of prepayments and any servicer disruption.
- Whether the $0.51 quarterly dividend is supported by recurring cash generation and REIT taxable income, rather than fair-value movements or financing activity.
- Progress on subsidiary licensing and Federal Home Loan Bank eligibility, and any changes to the related regulatory moratorium.
- Related-party management fees, reimbursed expenses and governance oversight, given the manager and servicer relationships disclosed in the filing.